Fed poised to keep record-low rates to aid rebound

[April 27, 2010]  WASHINGTON (AP) -- Confidence is growing that the economic rebound will strengthen. And to make sure it does, the Federal Reserve is considered certain to hold interest rates at record lows when it meets this week.

Fed Chairman Ben Bernanke and his colleagues open a two-day meeting Tuesday at a time when the economic outlook has been brightening. Employers are creating jobs, Americans are spending more, and manufacturers are boosting production.

Other signs point to a still-bumpy recovery. Unemployment remains near double digits and is expected to stay high all this year. Banks aren't lending at normal levels, and demand for loans is still low.

Despite a burst in home sales last month as buyers scrambled to take advantage of a soon-to-expire home buyers tax credit, the housing market is still fragile. So is the commercial real estate industry.

For all these reasons, the Fed is all but certain to leave its key bank lending rate between zero and 0.25 percent, where it's remained since December 2008.

"The Fed is more confident in the recovery and will send a stronger message about the health of the economy," said Bill Cheney, chief economist at PNC Financial Services Group. "But the Fed is going to be cautious, too. We aren't out of the woods yet."

Assuming the Fed leaves rates alone, commercial banks' prime lending rate, used to peg rates on certain credit cards and consumer loans, will stay about 3.25 percent. That's its lowest point in decades.

Super-low rates serve borrowers who qualify for loans and are willing to take on more debt. But they hurt savers. Low rates are especially hard on people living on fixed incomes who are earning scant returns on their savings.

Still, if rock-bottom rates spur Americans to spend more, they will help invigorate the economy. That's why the Fed also is expected to repeat its pledge -- in place for more than a year -- to keep rates at record lows for an "extended period."

Some uneasiness has emerged inside the Fed that that pledge could limit its ability to quickly raise rates when necessary. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, for two straight meetings has opposed the Fed's decision to retain the "extended period" pledge.

Hoenig said he fears keeping rates too low for too long could lead to excessive risk-taking by investors, feeding new speculative bubbles in stocks, bonds or commodities. He's also expressed concern that low rates could eventually unleash inflation.

Yet Bernanke and other Fed officials in recent weeks have made clear that the Fed's pledge to keep rates at record lows for an "extended period" is linked to the economy's performance -- not to a specific period. The Fed will raise rates whenever it decides it's necessary, Bernanke has said.

"If ... we anticipate changes in the outlook, then, of course, we will respond to that," Bernanke told Congress earlier this month. For now, though, "the best bet is that we'll see a moderate recovery," he added.

Once the recovery is firmly rooted, the Fed will start to boost rates and take other steps to drain the unprecedented amount of money it pumped out to fight the crisis. At their meeting this week, Fed officials are likely to discuss how best to do this.

One tricky question is when the Fed should start selling some of its vast portfolio of mortgage securities. The Fed bought $1.25 trillion of these securities to drive down mortgage rates and aid the housing market. Its challenge is to sell those assets in a way that doesn't weaken home prices and push up mortgage rates.

The Fed sees growth continuing this year. But it won't be as vigorous as in the early phrases of past economic recoveries, it says. As a result, the unemployment rate, now at 9.7 percent, will be slow to decline. It's expected to take years to recover the 8.2 million jobs wiped out by the recession.

Bernanke and Janet Yellen, president of the Federal Reserve Bank of San Francisco, President Barack Obama's top pick to be vice chairman of the Fed, argue that the "slack" in the economy will keep a lid on inflation.

Factories and other businesses are operating well below full throttle. Workers aren't likely to see hefty pay raises any time soon. And companies are wary of jacking up prices because consumers haven't shown signs of returning to their free-spending ways.

Low inflation gives the Fed leeway to keep holding rates at record lows. The soonest the Fed will begin raising short-term rates is the fourth quarter, 34 of 44 leading economists polled told The Associated Press in a recent survey.

[Associated Press; By JEANNINE AVERSA]

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